It's no secret that department stores have been struggling to adapt to falling mall traffic and growing competition from off-price and pure e-commerce competitors. Two major department store operators filed for bankruptcy last year: Bon-Ton and Sears Holdings. Several others have closed lots of stores over the past few years.
Dillard's (NYSE:DDS) certainly hasn't been immune to the recent pressure on the department store sector. Nevertheless, the regional chain has continued to open new stores at a slow but steady pace. Perhaps executives see opportunities in markets that rivals have exited -- but this could also be an example of empire-building by management at the expense of third-party shareholders.
Dillard's has suffered massive margin erosion
As I noted earlier this year, Dillard's adjusted pre-tax profit margin surpassed 7% in fiscal 2013 and fiscal 2014 but crashed to just 3.2% last year.
The company's margin woes have continued in fiscal 2019. In the first half of the year, comp sales declined 1% year over year. To make matters worse, Dillard's entered the period with too much inventory, so gross margin plummeted by more than 2 percentage points. As a result, Dillard's adjusted pre-tax margin fell to a razor-thin 1.2%, versus 3.3% in the first half of fiscal 2018.
On the bright side, it exited the second quarter with inventory flat on a year-over-year basis. That could lead to a little less margin pressure -- although Dillard's is probably still carrying too much inventory. In any case, it doesn't appear to have a viable plan to reverse the recent trend of margin erosion. Its long-term revenue outlook is also poor. Unlike rivals such as Kohl's and Macy's, the company hasn't invested much in technology and doesn't have a clear omnichannel strategy.
Yet Dillard's keeps growing
Given that Dillard's existing business is barely profitable -- and consumer spending is steadily shifting toward e-commerce -- opening more stores wouldn't seem like a wise investment. But that's exactly what Dillard's has been doing.
In June, it opened a second store at the Southgate Mall in Missoula, Montana. It will do the same at the Columbia Mall in Columbia, Missouri, next year. Meanwhile, Dillard's has agreed to enter the Grand Junction, Colorado, market for the first time, opening a store at the Mesa Mall in 2020. It was also supposed to open a store at the Empire Mall in Sioux Falls, South Dakota, this fall, although that project appears to have been delayed (or possibly canceled). Finally, around the time of Bon-Ton's bankruptcy last year, Dillard's considered opening several stores in Wisconsin. It has put that on the back burner, though.
In addition to opening these new stores, Dillard's is also spending a tidy sum to relocate stores at several malls in Texas into larger spaces formerly occupied by Sears. The first of those relocated stores opened earlier this year, with the others slated to open in 2020 and beyond.
What is management thinking?
Most of Dillard's new and expanded stores are in markets the department store chain already serves. So management ought to have pretty good data about demand there, reducing the risk of those projects. Opening stores in new markets seems like a more dubious proposition, but perhaps the company's market research showed a clear opportunity in those cities.
Shareholders can take comfort in the fact that most of Dillard's top executives are members of the founding Dillard family. They all own substantial stakes in the company and thus have a financial incentive to make sound decisions that will boost shareholder value. It's also true that while Dillard's is still opening stores in some markets, it has also closed a handful of underperforming locations in recent years.
On the other hand, high insider stock ownership is not a guarantee of good decision making. For example, Dillard's lack of investment in e-commerce -- the chain doesn't even have a mobile app -- seems incredibly shortsighted. Additionally, members of the Dillard family may have a bias toward expansion because of the prestige they get from having their name on a major department store chain.
It's certainly possible that this ongoing expansion will pay off. Still, expanding stores and adding new ones in an environment where margins are plunging and there's a meaningful risk of a recession in the next year or two doesn't seem like a prudent strategy.